FINANCIALIZATION AND OUR INCREASINGLY UNSTABLE ECONOMY
I finally got around to seeing the movie Inside Job, the story behind the credit crisis and winner of the Academy Award for best documentary. It’s very good and I highly recommend it to anyone who hasn’t seen it. It will certainly infuriate you. The movie doesn’t place nearly enough blame on homeowners, but all in all it does an excellent job of showing how Wall Street and government have become overrun by deregulation and sheer greed.
A combination of flawed economic theory and greed have combined to create the beast that we now call a “functioning” economy. The worst part of it all is that President Obama, who vowed change, has done almost nothing to fix any of it and in fact continues most of the policies that helped get us here in the first place.
In his latest letter Howard Marks touches on the regulatory debate. He says:
“A great source on the subject is Wall Street Under Oath, a 1939 book on the causes of the Great Crash of 1929 written by Ferdinand Pecora, who was counsel to the Senate committee investigating the crash and later a New York State judge. I first read it about twenty years ago, and I brought it out of storage in 2007. It is a typical polemic, assigning blame and touting regulation pursuant to what I assume were the author’s philosophical/political biases (see page 4).
Pecora describes a Wall Street that, up to and including the 1920s, was like the Wild West. Bankers and brokers were out to make money for themselves; their behavior was largely unregulated; and conflicts between their interests and those of their clients were widespread and disregarded. In particular, according to Pecora, disclosure standards were non-existent.
These facts combined with other causes to produce a market crash of epic proportions; widespread losses; a drying up of capital; deflation; and a massive depression with a resulting increase in unemployment to 25%. Unsurprisingly, fingers were pointed at the prior administration and political power shifted to believers in an activist role for government. The most lasting result was the enactment of laws that governed the financial system for decades and in many cases still do: the Securities Act, the Securities and Exchange Act, and the Glass-Steagall Act. Thus the 1930s saw a massive swing of the pendulum in favor of regulation.
The next several decades on Wall Street were – perhaps thanks to the impact of those laws – a relatively placid period. This led to a view that, with rare exceptions, market participants are well-behaved by nature. Further, steady growth with only moderate dips caused a perception of an inherently benign and productive economy that could achieve even more if only the regulatory shackles were loosened. After President Carter deregulated the transportation industry in the late 1970s, the door was open for much of the regulatory apparatus built in the early part of the century to be relaxed. Ronald Reagan, whose famously free-market views coincided with a period of peace and prosperity, led the deregulatory charge. We saw a similar turn in Britain under the leadership of Margaret Thatcher; the collapse of the USSR and a resounding victory for capitalism; and the ascendance of free market adherents Alan Greenspan and George W. Bush.
With the economy and financial system generating prosperity, people wanted more of the same. And with manufacturing in decline, we relied heavily on the financial sector for an increased contribution to GDP, job creation and standards of living. The prevailing view was that the less regulation we had, the more productive business and finance could be. And what was there to be feared from an unregulated economy, anyway? The result in the past decade, according to a great newspaper quote that sadly I can’t locate, was “the kind of regulation you get from an administration that doesn’t believe in regulation.”
Thus, coming full circle from the 1930s, starting in 1999 we saw revocation of Glass-Steagall; elimination of the up-tick rule limiting short sales to instances when stock prices were rising; a pivotal decision to exempt derivatives from regulation; increased permitted leverage at investment banks; and starvation of regulatory agency budgets. These developments were followed by the global financial crisis of 2007-08. Coincidence or causality?”
No, it’s most certainly not a coincidence. Marks goes on to argue that the markets and regulations will never be perfect so our economy will continue to be imperfect. It’s a rather defeatist and general attitude if you ask me. I think there are fairly basic rules that can and should be implemented that limit the potential outlier events from occurring. For instance, collateral on OTC derivatives would have substantially reduced the risks at the investment banks. Leverage limits. Higher capital standards. How about requiring down payments on homes? These are simple rules that eliminate the potential for some of the incredible risks we’ve seen over the last 25 years.
I am not an advocate of highly strict rules, just common sense rules. The fact that the NINJA loan ever even came into existence is a clear sign that allowing the markets to regulate themselves is bordering on insanity. Such lack of rules in capitalism is guaranteed to result in putting greed before rationality. I don’t want to contain capitalism. But I do want to keep it from destroying itself. That is the path we are on and the increasing instability upon which we build each recovery is a clear example….
In the movie, a prominent paper is mentioned written by Raghuram Rajan, a professor of Economics at the Chicago School. He shows how the financialization of the US economy is creating an increasingly unstable economy. Make no mistake, markets are not self regulating. This nonsense that government should never oversee the free market is disastrous policy that is driven by a misguided and dogmatic political perspective and a purely greed driven banking system.
It’s a great weekend read. Enjoy.
Nothing has changed since the crisis started. NOTHING. How can any sane person expect us to experience anything other than the exact same results of 2008 when nothing has been changed. I don’t know when it will happen, but it will happen again. Make no mistake.
It always interesting to observe those who seem to be most informed seemed to be the least aware. I humbly comment that your commentary on the issue of why our economy is failing is as is most economic contemporary participants and pragmatic observers superficial.
I would recommend you watch “Revolver”…Gambler Jake Green enters into a game with consequences.
I am not sure what you’re saying. I recall that movie….If I remember correctly the takeaway was that we are our only problem. Man is his greatest enemy. I don’t mean to misconstrue your words (so correct me if I am wrong), but are you saying that I am part of the problem?
We are all the problem.
Revolver begins by displaying the ego’s insatiable need for self gratification and preservation of it’s position of dominance over the rational mind, irregardless of the consequences of the affects on the self or anything else.
I would argue that participating in the market is ego driven and has little to do with fixing this relic of an economic order we call capitalism which does nothing efficiently and consumes man, plant and animal as if they were food for the ego, irregardless of the consequences.
The markets have always been a collective representation of listed companies, regulatory agencies, brokers, buyers or sellers. This is what people refer to when they talk about the market in the third person. ego is present through each of these entities and its actions are reflected in the markets on a grand scale.
So, what’s the solution? As Freud said, where there is id there is ego. It’s just not realistic to remove the ego from the equation. But it can be contained to a certain extent.
Awareness of self, stop deity worship and meditate to control the ego. Ahhh easier said than done.
In other words, humanity is hard wired for this sort of behaviour and once we get through this mess somewhere it will inevitable occur again. Buyer beware!
“Awareness of self, stop deity worship and meditate to control the ego.”
And consult Webster occasionally: (there’s no such word as “irregardless.” It’s just, “regardless.”)
But, regardless of the little mis-step, your post provides some interesting food for thought.
NYShooter…I can’t tell you how often I’ve had the abuse spelled out for me…I will strive to improve, regardless of my memories shortcomings.
that would be … irrespective of your memory shortcoming …
What blows me away is that now, we’re just getting around to possibly requiring [gasp!] 20% down payment on home purchases. The reaction? “This is going to kill the housing market!” Considering how low interest rates are, I can’t wait to see what happens to the housing market with just a tiny increase in interest rates. I agree, nothing has changed. Just more pain ahead. More whining by the masses.
I watched the film earlier this week. I think it did a great job in exposing the fraud that Larry Summers and the rest of his Ivy League gang are. It highlighted one of many reasons why nobody here expects change any time soon: top professors, which the politicians depend upon to provide a fair judgement, are actually Wall Street board members and consultants (at six figures a pop).
It was also good to see some details on Iceland included at the start. From what I gather, before the crisis Iceland was “financialized” to a level far beyond that of the USA. Yet, hasn’t Iceland managed to somehwat turn their economic situation around by “de-financializing” ?
I think it all started with good intentions at the academic level. These professors come up with all this garbage about the free market and how deregulation will unleash capitalism and growth, etc. It’s Milton Friedman, and an obsession with monetarism and supply side economics on steroids. It appears to work alright at first. We have a few hiccups along the way (1987, LTCM), but nothing catastrophic that the Fed and bigger banks can’t fix. So the professors rationalize their work and decide it only make sense to profit from this ingenius set of theories that resulted in all of this great growth. And then the Nasdaq bubble sprouts. And then the housing bubble. The credit bubble. We know the story. It turns out that these theories were totally wrong. They grew into one great big cannibalistic greed driven beast of a banking system that is now feeding off the corpse that is the US economy.
Unbelievably, people still listen to people like Summers, Geithner, Greenspan, Bernanke, Rubin and all of the others whose hubris has helped to crush this country. It’s really sad. It will take another enormous crisis to cement these people in the history books as the most destructive group of human beings that modern capitalism has ever known….And only then will we have a serious discussion about what has caused all of this. Then we can finally crush this monetarist and supply side nonsense and start moving the economy in the right direction.
“Unbelievably, people still listen to people like Summers, Geithner, Greenspan, Bernanke, Rubin and all of the others whose hubris has helped to crush this country. It’s really sad”
Th problem is that these guys tell America what it wants to hear, and thats why America listens. It’s like your analogy about the blind kid being told he will be a great archer. Thats what the blind kid wants to hear, so undoubtably he will be listening. The same principal applies here.
Americans want to hear Greenspan telling them to “tap there home equity”, because its appealing advise, right?
*advice* My spelling is going downhill…
People want to hear good news. The better it is the more willing to believe. Especially from the important rich financial ‘experts’.
I keep a copy of this issue:
http://www.time.com/time/covers/0,16641,19990215,00.html
I figure it’s an investment. The problem is that it’s so incredibly difficult to not give into temptation and put the cover on my dartboard, hence destroying its value.
Mediocritas, do what I did: print a copy, tape on dartboard, throw dart. Repeat til anger subsides (which may, in fact, take more than a few minutes I’ve noticed, so meal and sleep breaks are encouraged).
Excellent comment!
I have an additional comment or view that I don’t feel gets near enough discussion. I believe debating the merits of regulation or deregulation and its impact on “capitalism” will never be “honest” until logic returns to how we treat failure.
Due diligence has completely gone out the window in all levels of our markets……I don’t care if my bank is sound because I have FDIC protection, corporations don’t investigate their counter-party’s soundness because I’ll just take out a swap, we have the too big to fails who know it and take excessive risk because of it, we have govt subsidizing the entire housing market, we have mark to fantasy, we have the Greenspan and Bernanke puts, we set aside contract law and securities law when we wish to achieve a political goal, etcetc. In this environment, to say “deregulation” is a root cause of anything is laughable.
Regulations will never be able to stop or keep up with bad behavior. Regulations are not walls, they are like mazes that industry will spend much money and brainpower on finding ways to navigate. And there will always be more money and brainpower in industry navigating the mazes than there will be in govt creating them. In this context, we can begin to understand how finding the most effective ways to “self-regulate” are likely to have the best chance of gaining sustainable stability.
At the top of the list must be that failure is allowed to fail……there is no place for bailouts in capitalism…..if a company takes on more risk than they can afford to lose, is too late to a bubble of malinvestment, doesn’t perform adequate due diligence into the soundness of their counterparties, and their company therefore becomes insolvent…….they dissolve, period. And the personal wealth accumulated by the company execs in practicing the failure can be clawed back. The relationship between risk, reward and cost of failure has gone completely out the window……there is and has been no cost of failure, either in dollars or jail time, so who wouldn’t do the silly things that have been done?! When execs (and board members?) of an organization realize that their personal wealth is at risk if companies under their leadership go down, due diligence will improve almost overnight! Then, and only then, will confidence begin to return to our “markets”. Anything short of that everyone now knows can be gamed, for the benefit of the few at risk to the many.
Lastly, we should never again accept an argument like……”well, things would have been worse if we hadn’t bailed them out”. This is nothing more than an age-old political ploy…..claim the unprovable. How to treat failure is the real debate, in my view, that must come before any subsequent debate about levels of regulation. Thanks, krb
I like capitalism with losers!
There also has to be a “duty of care” element.
Due diligence simply isn’t possible for many people, not because they aren’t intellectually capable, but because they simply don’t have time. Instead they pay money to professionals to take care of things for them (often without any choice, eg compulsory superannuation contributions) only to watch it all go up in smoke.
It’s not reasonable for Bob the mechanic to be expected to monitor the activities of his super-fund manager in fine detail, understand the risks of subprime MBS and change funds accordingly because he doesn’t approve of the risks his manager is taking. We can’t possibly maintain a highly specialized society and expect everyone to be polymathic micro-managers. In modern society we *have* to delegate.
Bob the mechanic doesn’t deserve to be a financial loser for focusing on doing his job instead of following markets.
So regulation and oversight is essential to ensure that financial representatives are QUALIFIED to take risks and that they take serious consequences for getting it wrong. Financial representatives have a duty of care to their clients and failure to provide that care should be treated just as seriously as any other breach of duty-of-care in society. Predators that deliberately prey upon incompetent managers to inflict financial losses on the Bob’s of this world (for their own gain) are unethical but unavoidable if professional incompetents are allowed in the game.
Somehow, when it comes to finance, the law is blind in this regard. Financial predators and professional incompetents don’t go to prison, hell, they don’t even lose their jobs. They’re still pulling fat bonuses and partying like it’s 2006. Meanwhile, a lot of people are blaming the Bob’s and I (usually) don’t see it as reasonable.
Mediocritas:
You rock! A perfect rebuttal.
Thanks for contributing.
Good points, and I agree. If I understand you correctly early in your reply, due diligence isn’t ignored or replaced, but others are paid to do it? My view of regulating this outsourcing of due diligence, in the fund industry for instance, is to make sure INTERESTS ARE ALIGNED. Quite the opposite is true now, I know first hand as one of my careers was in financial services. My company counseled me to do things that were in the company’s interest but NOT in the client’s interests…..so I quit……and my company was not the exception, but the rule in the industry. When clients of a money manager lose, then the money manager and money management company must lose…….and once again, money manager performance will improve almost over night.
Once again, so long as common sense is used it would really take minimalist regulation to improve performance and trust in our markets. Instead we get these contorted concoctions for regulations in order to protect this constituency or waive the regulation for that constituency, etc…….once again setting up the system for being gamed (the maze navigated, from my earlier comment). Thanks, krb
You raise an issue here that bugs me a lot, the “paper wall” between client and prop desks. As you confirm, from your experience, this wall doesn’t exist; a moral hazard exists for the prop desk to exploit the companies own clients. A simple, common sense regulatory change would be to require an investment firm to make a choice, trade your own account or trade for your clients, not both.
While we’re talking about changes, a couple of other obvious ones spring to mind. First up, I would ban purchase of any CDS by an entity that does not have an insurable interest. This is just a basic common sense rule of insurance, yet it is NOT applied to CDS, creating an enormous moral hazard. In the case of MBS, this no doubt encouraged the deliberate origination of loans that would definitely default, chased up with a large dose of fraud to sell it all off to suckers.
Another thing would be to pull in ETFs. These things have exploded in volume yet few people understand what’s really under the hood. Many ETFs are purely synthetic and now that there’s actually talk of single-issue ETFs:
http://www.ritholtz.com/blog/2010/12/and-in-etf-news/
This is madness. The time has come to put limits on these things. They are nothing more than the modern incarnation of bucket-shops, under-regulated derivatives purchased by people who actually think they’re buying the underlying, creating the moral hazard to manipulate the price of the underlying.
I could go on and on but time doesn’t allow it.
Somehow we have re-defined regulation to be what it is not (whether purposefully and nefariously, or innocently as Cullen thinks the academics have done. In tandem, we attribute deregulation to supporting capitalism, which is a false argument. “Regulation can choke capitalism, therefore capitalism should be unregulated.” Wrong.
The theory behind capitalism was only meant to work in a closed system where the engaging parties bear BOTH the cost and benefit. Whenever there is spillover (an externality) then THERE is where regulation is needed — to ensure the cost not intrinsically borne by the benefiting parties is either contained, or allocated back to them.
Unfortunately externalities are usually difficult to measure or even observe. I don’t think anyone would claim requiring GE to stop dumping PCBs into the river is an example of stifling capitalism. Certainly it would be cheaper and therefore more profitable if we deregulated and allowed it.
The financial markets are no different. I think it’s clear there are quite a lot of costs associated with the current system not borne by the proper parties. This is exactly the job of regulation, and the government is failing miserably in its job.
Mediocritas, well said!
Regulation did quite well from FDR until Reagan.
Hear, Hear! Well said, Cullen — short and NOT sweet. Your journal is a vital record for future hitorians conducting a postmortem on supercapitalism, and these two paragraphs will appear in future textbooks and encyclopedia entries on free-market cannibalism. Greenspan, Bernanke, Summers, Geithner, Rubin, Obama and all the neolibs will thus live on in infamy.
It started with the academics. But if you really are pro free markets, you would not have supported the monetary bailout in 1987; the bailout of LTCM, and low rates for too long post dot-com.
If these things hadn’t have happened, we probably would not have been in such a mess now.
We probably wouldn’t have had a dot-com boom.
Inside Job did a great job of connecting the dots between Wall Street, Politics and education and the revolving door and nepotism. I also suggest you read Taibbi’s latest (Why is Wall St. Not in Jail?) which exposes the other piece of the puzzle – the lack of legal oversight due to the blurry line between the regulators and participants (once again a revolving door)
To sum it up, how can you ever effect change when its against short-term financial interests of the Wall St, and they basically own/highly influence the political, legal and educational systems which could catalyze any change?
A second American revolution? The response to this crisis really sounds like “Let them eat cake”.
didn’t larry summers call rajan a luddite because of that paper? he called someone a luddite…
Sounds right. In the meantime, Summers is to thank for our 90s budget surplus and financialization. This man is a walking weapon of economic mass destruction. It’s amazing he can still find a job doing anything….He’s been even more wrong than Greenspan.
And yet he is viewed by everyone as an economic genius (he’s the son of two economists, related to a Nobel economist, one of the youngest Harvard professors, former Chief Economist of World Bank…. and the list goes on). I can vividly remember Time magazine describing him as the “ultimate economic whiz kid”…. Haha
Hi Cullen love your stuff plus your readers replys and advise. Concerning summers (small capital) I would suggest to all to re-read “Globalisation” Joseph Stiglitz. Re summers term of office at the imf.
See: http://delong.typepad.com/sdj/2010/10/it-does-not-seem-to-me-that-charles-ferguson-has-gotten-it-right.html
There’s disagreement amongst people who were in the audience. The official transcript shows that he said “lead-eyed”, but many understood him to say “luddite”.
Just in case you don’t hate Summers enough, have a watch of this video about Brooksley Born, particularly chapter 4.
(Six chapters in all, the link is in the top right corner).
The smug, condescending look on his face as he turns to Born after the commissioner scuttles her (dooming the US economy in the process). Makes my blood boil every time. She’s one classy lady to control herself the way she did.
http://www.pbs.org/wgbh/pages/frontline/warning/interviews/born.html
Very good PBS piece. The whole thing was excellent.
same here. I have 2 comments:
- dogmatism is dangerous (but i think greenspan was too intelligent to be dogmatic)
- whenever a regulator is more concerned about regulated parties comments/situations than that of the people it should protect then there is something rotten going on
…and as the main street press regurgitates the useless regulation subject over and over again, the shemes of the Super Rich continoue almost undetected
…the GOP cover-up lie: “We are tax cutters, because we want you to keep more of your money.”
A more verifiable, restatement of the impact of their actions would be: “Our designated task is to legislate tax shifters to shift the tax burden onto middle-class voters so as to shift more of the wealth of the US upward to our core campaign contributors.”
…of course, everyone would like to be free of taxes. But only the rich have sufficient wealth to “buy up Congress” to give themselves enough tax breaks to shift the cost of running government off their shoulders onto the rest of society – and while they’re at it, to make sure that the government uses its resources to make the rich even wealthier, again at the cost of stifling the economy below them
…American society: Watch Out!!
for the last thirty years, tax shifts have doubled the proportion of the returns to wealth (interest, dividends, rents and capital gains) enjoyed by the wealthiest 2%, from a reported one-third in 1979 to an estimated two-thirds of the U.S. total today
…the end of this road?
flat-tax dystopia, that ends progressive taxation, freeing from taxes altogether the kinds of income that the wealthy take – returns to financial wealth and property
…un-taxing land rent, monopoly rent, interest and other financial fees, and insurance premiums (F.I.R.E) increases:
-the power of wealth, privilege, monopoly rights and property over living labor – including the power of hereditary wealth over the living
-helps “post-industrialize” the economy, creating a “service” (F.I.R.E) economy
Kind Regards
Here’s a different view:
Would it be a stretch to conclude that the financialization of the US Economy is a Modern Monetary Theory “full employment” goal?
The US and much of the West became stagnated post industrial economies in the late 1960s and 70s. To combat the this, governments entered trade agreements to take advantage of wage arbitrage and shipped off much of their manufacturing.
This (as well as tech advancements) eventually created a deflationary force on prices… careless money printing ensued whose affects where felt on asset values. Which in turn spurned the Ponzi FIRE economy.
I agree that bankster criticism is warranted. But let’s be honest. How many title companies, paralegals, legal secretaries, real estate agents, insurance agents, pension fund managers, etc… also rely on this Ponzi Finance (FIRE) Economy?
Didn’t this new economy soak up a lot of the post industrial unemployment the West experienced in the late 70s and early 80s? Parents watched their children graduate college and enter the FIRE economy. This was seen as progress.
So we just witnessed the fruits of MMT and “full employment.” The result? The greatest credit bubble in the history of the world leading to the greatest trade and debt imbalances and the greatest mal-investments in the world.
Get ready. This sucker’s coming down. Untold unemployment and a crashing aggregate demand awaits us. A distorted unsustainable economy that relies on the unrealistic exponential growth of credit expansion for consumption just can’t go on forever.
Reality always catches up. Systems tend to self correct. The fall of 2008 was an example of this. We’re not out of the woods yet. The system will ultimately have its final say.
http://fiatcollapse.blogspot.com/2011/01/confusing-mathematics-and-morality-in.html
when the current equity bubble pops, this time with mainstreet in the dumpster, a true unemployment rate of 15.7%(if u count people who have given up looking for work-and why wouldn’t you?), 5-8 yrs. of housing sitting(11% are empty), eur hanging on by fingernails- merkel in trouble in coming elections……i could go on but its saturday morning…..
its going to be the big one.
maybe we will get some change instead of a campaign slogan……but not as long as it takes BIG money to campaign.
Anyone who thinks MMT and financialization are compatible is clueless about MMT. We’ve written at least as much on that topic as anything else, so that’s just about the most ridiculous and ignorant statement that could be made about MMT.
Right.
Ignorance? MMT’ers often overthink and miss the obvious.
Just ask yourself this question:
Would a banking system prefer a commodity backed monetary system, or a fiat system that can be expanded at will and where the government’s seigniorage profits are ridiculously high?
Which type of system is more amenable to banking bailouts?
MMT’ers are also ignorant of human nature. The road to hell is paved with good intentions.
Ha. That’s an absurd statement. I spend half my time talking about human nature and psychology. You clearly need to brush up on what MMTers actually believe….You don’t seem to have a clue. You’re trapped in your dogmatic Austrian economics framework….
Cullen, I expected more from you than a brush off.
This isn’t about which economic school of thought is better. Personally, I’m an agnostic. I can find faults with all schools of thought. But my criticism on MMT is warranted.
So answer the question:
Does a banking system prefer a gov’t with a commodity tied monetary system with low seingorage return by the gov’t, or a fiat electronic system where seignorage is very high?
It’s a simple question, really. Calling arguments absurd I guess is an easier answer.
And keep in mind there are two arguments here. One is the ability of monetary expansion under different monetary regimes and the consequences of the expansion rate, the other argument is a political argument based on value preferences – what to spend, how much, and why under different monetary regimes.
The political argument is a no-brainer. For the most part, I share the same values with many MMT’ers – even you. Our difference lies in our faith in government and elites, hence the road to hell quote I mentioned above.
Misthos,
It was absurd. No regular reader would ever accuse me of not considering the psychological impact of govt action. I spend half my time here talking about how govt policy influences the actions of economic participants. It’s ridiculous to accuse me of not focusing on the psychological aspects of all of this….
We live in a fiat system. So, I work within that framework. It does not matter what you think it should be or even if you prefer a commodity based system. We live in a fiat system. Hence, why I apply MMT to our system….It is what it is. It makes no sense to apply a gold standard model to a fiat system (and that’s what most economists do).
The thing is, we live in a fiat world and we aren’t going back. There are simple reasons why we moved from such a system and I just don’t think it’s realistic to theorize about moving back to the gold standard. So, I just don’t see the point of theorizing about the gold standard. It failed. It’s not coming back. End of story. So, we must move on and recognize the flaws in fiat and restrict those flaws from being catastrophic.
That’s where we disagree.
The “potential” catastrophic consequences of fiat you fear, in my opinion, have already occurred. The after effects are slowly taking hold and materializing. Central Bank manipulation and fiscal deficit spending is only slowing down the process, while creating a larger collapse in the future.
And when I criticize MMT, I criticize fiat. I don’t view the current system under a gold standard lense. I view the current system for what it is, and what it has produced: distorted economies, malinvestments, and grave global economic imbalances and debts. These are the elements that will contribute to the catastrophic consequences you fear. You see, the foundation has already been laid for collapse.
You’re dead wrong about fiat not going away – but that’s a separate argument. The process of it going away has already begun. It is geopolitically driven. Fiat can not survive in a world of scarce resources. Which is another MMT issue. It seems to me that MMT’ers focus on domestic economies and forget that there is a world out there of many nations competing for the same limited resources. We are bound for conflict as fiat fails.
The multi-millenia history of global trade and finance has been conducted under a commodity standard of sorts for a reason. It has only been the past 40 years that the entire world has gone fiat. To think this newborn system of global fiat is permanent – well, that is absurd.
You can have the last word if you wish…. it’s your backyard, your football. I have my own blog that fleshes my views out.
The gold standard was tried. It failed for a reason. Because it created its own imbalances that resulted in horrible depressions. Just look at Europe. That’s exactly what single currency systems do to countries. If you want to return to that then please be my guest and go to Ireland or Greece and tell me how much fun it is to find a job….fiat is imperfect, but it’s far better than the alternative.
When the risk free rate of interest is zero or one percent and the inflation rate is two percent+, malinvestment will occur.
It is the height of ridiculousness to blame the people who chase yield and the people who sell them the high yields and the regulators who give the high yields a good rating.
Rates are zero right now. If anyone thinks that malinvestment on a massive scale is not taking place, they are badly misinformed.
When all this malinvestment is exposed, who’s going to get the blame.
Well, you can bet there will be another movie and plenty of books that all agree that greedy rich people are to blame and what we need is much more gov’t.
Do you really think that if banks are regulated, there won’t be any bubbles when the rate of inflation is much higher than the rate on gov’t bills? Have you heard of what happens in commie countries where it’s all regulated? It’s called black markets. Money always finds a way to try and protect itself from inflationary theft.
The lens of the left will scoff at what i say and go right on back to agitating for zero interest rates, more regulation, and, when the malinvestment collapses, will be right back to the playbook of blaming the evil, rich, greedy, capitalist.
Sound money and reasonable rates is the only real solution.
I can read the tea leaves, though. I know it’s not going to happen. And i know who’s going to get the blame when it collapses again.
I believe your deductive reasoning is flawed. To correlate the current environment of negative real yields with the preceding activity of investors investing in securities that were sold by investment bankers who were aware they were committing fraud on the investor and were allowed to do so due to the absence of regulators is ludicrous.
You participate in this forum which leads me to believe that the odds are better than even that you are older than 6 years of age. I would assume that you believe that white collar crime exists? You believe that managerial and financial accounting serves a useful purpose by presenting to investors a corporations worth both in the present and through time? That the Enron bankruptcy demonstrated that fraud exists in corporate finance?
To assume that the onset of real negative interest rates leads to commie black market doesn’t know the likes of Paul Volcker.
Reenact Glass Steagall and caps on leverage, strengthen capital standards, phase in a legal bar on the FED bailing out bank bondholders (i.e., protect depositors only) and break up any remaining TBTF institutions as unacceptable systemic risks, and the bankers will be back in their cages in short order. The way is clear; it is the will that is lacking, due to the systemic corruption of both major parties and the FED in the US and the difficulty in coordinating an international structure along the necessary lines.
off topic, but I sold some gold today and couldn’t resist getting into an argument with the shopowner about modern monetary theory. (he started it, i just couldnt bite my tongue) I’m sure he thinks I’m a lost evil deficit spending liberal. He said that they do very little hedging and are a buyer at any price. Sounds like a recipe for ruin. There was an older couple in the shop also and they were asking if they could convert all of their 401k and Ira to gold coins. scary. I held on to half of my gold, hope I’m not waiting too long to cash it all in. My guess is that we still have a ways to go and I am trying to force myself to let my winners run longer. (I’m the ultimate contrarian indicator either way. I hold onto treasuries after a 20pct run up and then get clobbered. I sell aapl after a 30pct run up and then see it keep going. )
Gold is always good for an insurance policy. But it’s never wise to keep all your eggs in one basket….I don’t think we’re quite at our 1980 moment for gold, but we will likely get there in the next 2-5 years….Either way, if you’re overly diversified in gold I don’t think it’s unwise to slowly allocate out. And if you own none it’s not too late to own the insurance….
Read Steve Keen. Basically, after Volker, the Fed never “Took the punch bowl away” again. For thirty years banks expanded credit and found reserves later. Credit money expanded to not quite four times GDP. It was two and a half of GDP in 1929. It was half of GDP after WWII the end of the last depression. Our current depression will not end until a similar contraction in debt occurs. By calculation, only Zimbabwean deficits can provide net savings equal to this debt overhang. The only other path out is debt default. Growth is hopeless. I doubt we will hyperinflate. That leaves debt deflation and depression.
The policy problem is that the instability is seeded by Ponzi lending to asset flippers who get guaranteed returns by credit expansion driven inflation of assets being flipped. Once this starts, the central bank is trapped because any attempt to stop Ponzi lending results in recession. The FIRE segment grows. Deep capture of regulators occurs. Control fraud ensues. Thirty years after the start, the end game is the train wreck we now see coming. Because the problem begins with banks, and remains obscure to regulators and central banks, Keen advises the solution is to block Ponzi lending. Real estate loans limited to not exceed 100 times monthly rental value and stocks to revert to so called Jubilee shares with finite life once traded. I believe Keen is closer to understanding causes and solutions than Chartalism or MMT.
MMT proposals on this are far more sophisticated than Keen’s. And Keen gets the accounting wrong over and over again. Keen relies on Minsky for is understanding of this, but Minsky was an MMT’er.
I have read just a little on MMT. The main thrust seems to be all about the axiomatic truth that net savings and deficit spending are equal in closed economies. Trade imbalance is a trivial and secondary consideration for open economies. Keen dabbles a bit in MMT by introducing so called vertical flows of money injected by government and horizontal flows of credit creation by banks. If aggregate debt is forty two trillion doesn’t this require forty two trillion of deficit spending creating fourty two trillion of net savings to retire this debt? I am interested in this question because I believe it lies at the heart of our current predicament. I would love to see a policy option that credibly unwinds aggregate debt without a second Great Depression.
Keen doesn’t dabble in MMT. He is a circuitist which is essentially a (far) less comprehensive form of MMT.
@ Scott Fulwiller:
Hey, most of junior readers (= read mathematicians working in OTHER fields actually DO get MMT in the sense that we have read through BillyBlog’s ATAM’s (account transaction matrices (actaully spreadhseets) to get the accounting (dual accounting identities) – I have yet to find the flaw in the math – OK.)
With that said, while MMT gives an accurate prescription of how money actually flows- what justifies guarantees of Full Employment? Cf. Billy Blog’s CoFFEE!
What justifies that? (His report that “There is no financial crisis so deep that cannot be dealt with by public spending” CofFEE working paper No. 08-10 (Juniper, Mitchell – aithors).
This report bothers me in several ways. While I find that “free market” concepts are typically hazardous (b/c the “market” is no longer “free” and won’t become to be so until we return to a GOLD standard = NEVER). Actually, the “free” markets haven’t been truly (Austrian) markets for since FOREVER! Why do these Austrians complain so much? It is about complaining that we have Nuclear Science deployed in reactors, or about complaining that we have electromanetic sensing systems in radars that are in certain airplanes! It is almost Luddite.
But here is a tip. In order for this discussion to move forward in a constructive manner – we have to define some things.
We must first define a “FREE MARKET” – that term gets thrown out TOO many times to be constructive. Let’s pin the “TAIL” on that donkey.
Define what it truly means – and then, DEFINE the controls that would make some sense (ummm…. like Capital controls????, etc.)
But please realize, that MMT in it’s various (developed) forms has the appearance of FASCISM – especially when it involves FULL EMPLOYMENT.
Some judiciousness is needed here to bridle the unconstrained markets from the damage they have done (as well as the Fed!!!),BUT, to involve Gov to answer this issue is what we typically define to be FASCISM (a very negative word).
While I feel that MMT has an accurate description of the money flows in a FIAT non-convertible currency system – I feel that there needs MORE thought about managing the flows – that wheels in the “free” markets, in a manner that it can be DEFINED and brought forward…
peace man, Love your stuff, & especially enjoy when you are a guest contributor here.
If you even come back to this post – that is cool too (hey man, it’s ALL good)).
Be well, Scott
The basic justification for the JG is several fold. In terms of stabilization policy, it’s a way to run a functional finance fiscal policy automatically–that is, if it runs as desired (a big “if,” for sure, in my view), it will automatically have significant stabilization properties. You wouldn’t need Congress or anyone else to make any decisions in real time, since the JG on its own will increase and reduce deficits countercyclically, and will do it by directly creating work “off the bottom” that then won’t be inflationary.
I don’t think it’s defeatist to recognize that capitalism is inherently unstable. It’s just realistic. It doesn’t mean that nothing can be improved, only that you shouldn’t believe that any change can “fix” the problem once and for all. Also, regulation following a crisis should not be credited with the calm that follows…the calm is a result of chastened market participants; the regulation is only a symptom of the chastening. Regulators have the same biases as everyone else, unfortunately.
Aye to that, Max. Capitalism sucks. But it sure is a hell of a lot better than any economic system mankind has ever devised.
Instability of capitalism is basis of specluation. A stable system is for financing entrepreneurship, based on investing (remember investing to share in profits?) prudently.
Nothing changed from this crisis. Nothing will change from the next even if its bigger. To believe otherwsie is not to believe what makes the world go round. Vested interests who control the political body will continue to keep things as is and they have a central banker aiding at every corner.
If you told in 2005 what was to come in the next 5 years you would swoon and assume all the world would change 180 degrees. Instaed we changed 5 degrees and mostly cosmetic. So shall be the same review when we look back in 2020 to whatev er is coming to us. Good luck believing anything else
So the answer to avoid future market crashes is to have imperfect men regulate imperfect men? Let us all be honest here. Keeping your winners and socialising your loses is NOT capitalism. From LTCM to here this is what has happened. If you have every traded or invested your own money you will know what the BEST regulator was, is and always will be. That is; taking your losses.
I don’t disagree that there must be losers. But there also must be simple rules. Having people put down collateral for loans is a rather simple one. We never would have had a housing crisis if homeowners had been required to make downpayments on the largest purchases of their lives….Is that too much to ask?
In a full on Ponzi lending environment, greater fools will still put 20% down, or bankers will find a way to provide the down payment in a separate loan. There is no stopping the end game once the mania is pandemic. The answer is to stop the Ponzi self delusion at it’s start by somehow forbidding any lending predicated on asset appreciation without some value added activity. Bankers must be forced to do their jobs. Banks should be capitalized like insurers by “names” as Lloyds of London is. This is a good use for the capital of the truly rich, the few thousand who own half our wealth. This might stop the banks from privatizing profits while socializing losses. We need our oligarchs to have some skin in the game to balance the corrupting influence of upstart bankers. Old money as a throttle on new money if you will.
I actually work in insurance and do a good deal of work with a few of the Lloyd’s syndicates. I think that your idea of having banks back financially this way is brilliant. Of course it will never happen, but its brilliant none the less.
It would be a great way for our banks to not be so “financialized” and basically there would be no mom and pop investors, no 40 somethings holding a few hundred shares of C in their Scwabb account; there would only be names who’s losses are obviously there own. Having the goverment bail out banks that were funded that way would be the beginning of a revolution from the middle class for sure, which in turn would make sure the government doesn’t bail them out and those Names become the losers we so desperately needed 2.5 years ago.
Wow I hate when my grammar and syntax are as bad as they are above.
I would offer an edit tool if it didn’t chew up so much site speed….sorry.
My mistakes are mine, no need to apologize.
I don’t believe this to be true.
People are faced every day with pages of fine print and smooth-talking salesmen. Heck, how many people read their cell-phone contract? Even if you do, what can you do about it – you want a phone, right? What about your auto insurance or your car loan? You need to drive to get to work.
Many who took loans with adjustable rates simply didn’t understand or were sweet-talked into believing that things wouldn’t change. Having them put 20% down would just protect the banks with personal money instead of government funds (ala bailout). We teach people to trust professionals. Heck, we can’t even trust the likes of Summers, Greenspan, etc. Do you really think you should be trusting your real estate agent or the bankster on the corner. People think that an appraisal means something – it means nothing, except in relative terms, even when done honestly.
You might argue that people shouldn’t buy a home if they didn’t understand what they were getting into, but EVERYONE was telling people to buy a home. We’re still doing it. People are suckers for a salesman. Even smart people.
We shouldn’t chastise people for wanting a home.
From an MMT perspective, there were obviously the resources available to make houses for lots of people. The only thing we were short was money. We could have fixed this by giving people money, or forcing banks to take a haircut. We did neither. The country gains NOTHING by throwing people out of homes now left vacant and deteriorating. What a waste.
This has nothing to do with MMT.
The point is, if people had been forced to put 20% down home sales would have been astronomically reduced and the bubble probably never becomes a bubble in the first place. But the banks went for profit over prudence and the consumers went for home at no cost. Can you blame them? There were no rules in place to stop the ignorant and imprudent from protecting themselves.
Why can’t you people see that the rest of the discussion is moot once you face TPC’s 20% down payment point? IF 20% down payment were required for the loans, THEN crisis wouldn’t have happened. Who can contest that with anything other than something that happened FURTHER down the road once there wasn’t that down payment required?
Right. Or we can at least be certain that the crisis would have been far smaller. Without the shady NINJA loans and the like the homeowners never get the loans and the banks never repackage them. End of story right there….That’s one simple rule that eliminates an enormous systemic risk. Do we shave a 0.5% off of GDP per year? Maybe. But do we eliminate the risk of total collapse due to a housing bust? Yes. Worth it to me.
Agree
But isn’t that what we all did for years when getting a mortgage. When the dishonest offers of little or no deposit came along, disaster followed.
Duh! This is called Winning! Cullen
!
I do not usually post comments. But wanted to take the opportunity, today to thank you for the efforts/blog.
http://market-vipasyana.blogspot.com/2011/03/2-year-anniversary-from-bottom-stock.html
You need to start — along with others like Hussman and Kaiser — a campaign to organize a million people march in various cities, against the fed and central bankers around the world.
I for one am tired of hearing that Free Market Capitalism has failed. We have not had Free Market Captitalism, rather we have had Crony Capitalism. Forcing the banks and financial institutions to eat their loses from the beginning would have solved many of the problems that we currently face.
I would argue that we would not have had a housing crisis if the banks had known categorically that they would not be bailed out, if they had known that they would go to the wall. If that had been the case would the banks not have demanded large downpayments? I strongly disagree that passing more regulations (that ultimately will be easy circumnavigated by the larger institutions) will solve the problem. I say, let’s try real Free Markets. Let them make risky loans at their own peril.
I agree with gg. Should be noted that this should be taken to the nth degree. That is, banks will try to off load their mistakes by reselling, subsequent holders then protect through default swaps, etc etc. With a policy of no bail outs anywhere down the food chain all that insurance becomes potentially non-existent, and more care will be taken by the participants back up the food chain.
Greed will never be eliminated from human behavior, so find a way to have it work for the system rather than against it. The best chance at some stability is to use greed (fearing the loss of everything) to help stabilize the system…….total dissolution of companies and clawback of gains by execs. As a simple example, why do down payments work? Its skin in the game, fear of losing it. There is no need to demand it through regulation, you just take away the safety of off-loading the risk, and the banks will demand it themselves for self-preservation.
Regulation, de-regulation, all takes a back seat in causation, in my view, to the bail out culture we created through Santa Claus governance. Thanks, krb
Do you believe in bank auditors and bank regulation?
Auditing to insure what you say you have/did, is what you actually have/did, is useful. Bank regulation to the extent it defines what “banking” is and therefore what qualifies for bank/FDIC protection (if we keep it) is also useful……I think dissolving Glass Steagall to open the door to voracious speculation by banks meant for conservative saving, checking and lending was a disaster.
I don’t want all my comments here to be misunderstood……I’m not against all regulation. I simply do NOT believe more, and more, and more, and more regulation in response to every newly developed act of greed (what do you think “financialization” is?) will ever be effective……new financialization products or schemes will always remain one step ahead of govt regulation to control the last generation of financialization. Eliminate all bailouts (follow policies of corp dissolution AND exec claw-backs) and I believe we’d all be surprised how little regulation it takes to bring stability.
Thanks, krb
Enforcement of current regulation is helpful and rules around what is off balance sheet and what banks can/cannot invest in is important.
Inside Job is probably the first complex documentary about the crisis, nevertheless it’s still really, really bad. I mean, I’ve seen amateur conspiracy documentaries that were much more professional than this. Blaming the “evil” guys from Wall Street for everything while defending the innocent, poor people… Very manipulative, very misleading. Of course, big mistakes were made by the “big” people, but people should rather be educated not to repeat their own wrong decisions.
Do not agree. When i loook at diploma, wages, bonuses and responsability of those “evil” guys i expect them to be more responsible and accountable when they sell crap than average joe is when he reads 10 pages contracts.
We have not seen indeed a real free market capitalism. We will never see it. It is a pure paper theory…human behavior is what it is, it radicall yimpact all paper theory…Let’s face reality…let’s be pragmatic
The “financialization” of the economy is inevitable.
It’s a basic mathematical problem: Aside from productivity gains, the only to increase the general level of prosperity while simultaneously controlling inflation is to use leverage, i.e. debt.
And since the world economy is expanding and producing excess wealth, it is inevitable that investors will plow at least some of that wealth into profiting from that leverage.
Equity creates debt, which feeds spending, which drives asset inflation, which creates volatility. If you don’t like that cycle, then you need to limit leverage and curtail the demand for prosperity, excepting that the trade offs will come in the form of reduced, more costly consumption and higher unemployment. The former will upset the lenders and the political conservatives, while the latter is bound to piss off just about everyone else, so it ain’t gonna happen.
Of course, but it becomes problematic when the debt levels grow in excess of what is sustainable. That’s how you get depressions.
it becomes problematic when the debt levels grow in excess of what is sustainable
Of course. But voters don’t want to deal with the alternatives, hence the current dependency upon asset inflation policies in order to prop up the system. No politician wants to suffer the backlash, and the Fed wouldn’t have the ability to do much about it, even if it wanted to.
Agreed!
> the “financialization” of the economy is inevitable
?? Bullshit. The very idea that one can adequately define the adaptive options of human populations in financial terms is so mathematically impossible that it’s embarrassing to see it even broached, let alone engrained in captured government policy. If it were that easy we would have “financialized” the Marine Corp long ago, and wouldn’t have had to fight ~7 of our last significant wars.
Haven’t seen a sane statement on this issue since FDR:
“But while they prate of economic laws, men and women are starving. We must lay hold of the fact that economic laws are not made by nature. They are made by human beings.” Franklin D. Roosevelt
“The real truth of the matter is, as you and I know, that a financial element in the larger centers has owned the Government ever since the days of Andrew Jackson — and I am not wholly excepting the Administration of W. W. The country is going through a repetition of Jackson’s fight with the Bank of the United States — only on a far bigger and broader basis.”
Letter to Col. Edward Mandell House (21 November 1933); as quoted in F.D.R.: His Personal Letters, 1928-1945, edited by Elliott Roosevelt (New York: Duell, Sloan and Pearce, 1950), pg. 373.
The very idea that one can adequately define the adaptive options of human populations in financial terms is so mathematically impossible that it’s embarrassing to see it even broached, let alone engrained in captured government policy.
Given our mindset, it is inevitable.
There is simply no way for our society to simultaneously support mass consumerism, improvements in our lifestyle and low inflation without also running a trade deficit; we need to take advantage of wage arbitrage in order to provide goods in ever-increasing quantities and at low prices.
But if inflation is low, that naturally means that wage growth is low. (It isn’t possible to have low inflation and substantial wage growth simultaneously.) With our expectation that our lifestyles are supposed to be steadily improving (read: our consumption needs to keep growing), there is this never-ending challenge of having to pay for the stuff that we want even though we aren’t increasing our means to pay for it.
And since we aren’t earning more, we need to fill the gap by borrowing it. It’s really as simple as that. We can’t have all of these things at the same time, yet we want them.
Meanwhile, the developing world is adding hundreds of millions of people to the world’s base of producers. The size and scale of this increase in prosperity is unprecedented in human history. These people are making money and they’re going to want to invest some of it. It shouldn’t be any surprise that some of that money is going to be invested in our debt, because its repayment is supported by the world’s largest economy. You can’t fault them for giving the rope to hang ourselves when we’re so busy designing a fashionable noose that will fit around our necks.
Jackson was against the US bank because the managers were using Gov’t money for private investment and keeping the profits for themselves.
Heard a Recap of Dennis Prager’s Interview with Paul Sperry.
Paul Sperry released a new book over a month ago titled” The Great American Bank Robbery:: The Unauthorized Report About What Really Caused the Great Recession
He Claims it was OVER REGULATION… He specifically called out the HUD and FanyMae etc and Mainly Politicians who caused the mess and then pretended to act on our behalf only to allow the mess to continue. He had some strong bullet points.
I did not catch the whole interview but was wondering if anyone knows much about this guy?
I don’t see how that argument flies. If there was a simple law that required 20% down on homes the crisis never would have been able to occur in the first place. It’s that simple. I am not saying the rules need to be that strict, but you can see the obvious point here…
OH Yes, I hear ya brotha love.. Quick Story.. I some salt of the earth folks from our Church were buying homes back in the early 2000′s as a “Mission” to help folks get into houses. They told me about their lenders who were helping them. Now mind you, these were salt of the earth Churh type folks just looking to help others.
Well, the Lenders that were helping them, were also doing it snaky. I went in and applied for loans with them.. And the Game was to apply for as much as you could get and then double down with in the next 30 Days before the first mtgs went onto your credit rating..
It was not told as simple as I just said, but that was basically how it worked. I saw right through it and informed my these friends about it and my opinion and they quickly severed ties, but were already knee deep in many multiple mtgs.
Paul Sperry is a right-wing ideologue with the Hoover Institute. He used to write for Investor’s Business Daily, which has one of the nuttiest op-ed sections in the US business press.
Sperry is just beating the same old Fannie/ Freddie drum that is typical of the political right, as they seek to engage in damage control and otherwise avoid assuming any responsibility for their role in the crisis. The fact that you would have heard him being interviewed by Prager, another right-wing zealot, is not a surprise.
Not sure where to post it, but I’m very curious about your opinion of the latest Hussman article regarding Q.E. and asset price increases:
http://www.hussmanfunds.com/wmc/wmc110307.htm
Hussman has been totally wrong about QE. He said it would crash the dollar and that it’s helping to fund that deficit. He’s got it entirely wrong….
So the dollar is stronger since QE?
InvestorX
Has it collapsed like predicted?
Your comment about not enough blame on homeowners amazes me.
The reaction of the general public was completely predictable given the circumstances.
The government and banks created an environment beginning in the early 90′s that consistently rewarded the public for leverage and having faith in ever escalating property values. At the same time this policy punished anyone who was fiscally conservative.
After 15 years of irresponsible fiscal policy where anyone who did not leverage themselves was left behind in a world of exponential wealth expansion, even the prudent began to give in to the pressure.
The homeowners did not create the irrational fiscal environment; they were simply trying to survive in it.
The so called experts were in charge of the runaway locomotive and they continued to support the status quo even after the system collapsed from its own weight.
The really scary part is that they still have not learned anything and continue to believe we can simply spend and speculate ourselves out of the ruins of what was once a prosperous economy.
Its not so much that markets are not self regulating. Its more that its not a market when capitalism as no consequences for losers, when rates are manipulated and not reflecting risk, when mortgage lenders writing mortgages where in a completely nationalized market in which the government backs literally 99% of all mortgages and then the Federal Reserve bought $1.2 trillion in mortgages that no sane private investor in a real market would touch. A so call market where you can take your keys back to the lending bank and get rid of your obligations, where government encourages and even forced bank to lend to unqualified buyers. Then after the fact every one is surprise and talk of regulation.Sorry but you cant regulate bank robbery. There are more regulations now than ever but the problem is that there are as many lawyers and if a market is not transparent its not a fair market no matter how many regulations.
If you think the President plans where about change
Consider the Contributions to federal candidates and political committees by lawyers. The industry contributed a massive $234 million to federal political candidates and interests ND 76 percent of which went to Democratic candidates and committees and where are the best paid lawyer? Wall Street.
Is it not true that banks are now more emboldened due to being bailed out. They have learned a lesson. There is no reason for them to think that they will ever have to eat their future loses. In the meantime it’s easy to pay lipservice to more ‘regulations’ but my question is this. Where are these angelic banksters going to come from, you know, the ones that are not going to loby and buy their way around the regulations? These angelic banksters that will resist the temptation to take advantage of their risk free environment? Do they even exist?
Isn’t it time we really tried Free Markets???
Where are these angelic banksters? They are having lunch with the angelic politicians.
Isn’t it time we really tried Free Markets???
You must be fond of having depressions every couple of decades. Because that’s exactly what we used to have before the days of the FDIC and deposit insurance.
Nostalgia is fun. But learning from history is better.
We spent the last 20 years trying a form of free markets and the banks used it to rape and pillage the US economy. I agree that banks should not be bailed out. They should sleep in the bed they make. But that doesn’t mean they should be without regulations. That’s how you get into this mess in the first place. If you have the proper safeguards in place then the bailouts are never necessary. But we deregulate everything and look where it gets us…..
How many bank bailouts were there in the 40s, 50s, 60 and 70s under Glass Steagall?
Actually I was all for guaranteeing deposits and letting the insolvent banks go to the wall. Many banks would have fallen but we would have been left with a healthy foundation with the healthy banks remaining deservedly being rewared with new deposits. Additionaly it would have sent out a very clear message that you take on risk at your own peril. This is called Free Market Capitalism … isn’t it time we tried that?
Actually I was all for guaranteeing deposits and letting the insolvent banks go to the wall.
Think about what you’re saying — you want to both socialize the losses with deposit insurance, while simultaneously going out of your way to maximize those losses. You want to push up the price tag of the costs borne by the taxpayer.
I realize that it’s good fun to call them “banksters” and to demand their destruction. But deposit insurance necessarily results in socialized losses, which makes “too big to fail” an unavoidable problem.
It should be pretty simple — if we’re going to make a public policy decision to insure deposits, then we need to regulate the hell out of the banks so that they don’t abuse the insurance. “Free markets” in the form of deregulation are completely incompatible with an insured banking industry.
Right!!!
Angry MBA,
Yes I have thought about what I am saying and that is that retail bank deposits (money that main street deposited in their bank accounts in good faith, that is, money they are NOT speculating with) should have been guaranteed. Purely for the reason that they did not act irresponsibly. The banks that took on these risks and the SPECULATORS who invested in those banks should have taken a full hair cut if necessary.
BTW, socialising the loses refers to profits being kept by the speculator (banks and investors in those banks for our discussion) and the loses being socialised (that is, being shouldered by the tax payer). It does not refer to protecting bank deposits.
Irresponsible banks and the shareholders need to take the hit (it’s only fair as they were the ones to benefit from their irresponsible lending practices). Retail depositers were the innocent party here and as such should not take a hit.
Irresponsible banks and the shareholders need to take the hit (it’s only fair as they were the ones to benefit from their irresponsible lending practices). Retail depositers were the innocent party here and as such should not take a hit.
I actually agree with that.
But you’ve spent a lot of time going on about “free markets”, when what you actually seem to be calling for is the Swedish solution of bank nationalization, i.e. doing something similar with the banks that was done with General Motors (cramming down debt, converting bonds into deferred equity, etc.) Good idea, but not at all in sync with what one would normally associate with pure free market ideology.
This is easily fixed by simply ending banking as it currently exists.
Most people don’t put money in a bank as an investment, they put it there so that their ATM card works and they don’t have to carry a bunch of cash or store it under their mattress. The money storage business that banks are in should be one business, separate from lending. No deposit insurance would be necessary as one could require these non-banks to invest in govt. securities.
People who want to play the bond/loan market can put money in an “investment bank” and assume the risk that goes with it. That doesn’t mean such institutions should be unregulated, just that such a separation would simplify the regulation and understanding of these institutions.
I maintain, there is no greater regulatory effect than the sure knowledge that if you take on irresponsible risk you will pay the full price. Why are Free Markets better than stacks or regulations? Go ask anyone who lived in soviet era USSR … they might tell you that in the real world, bankers and those who regulate them and any politician for that matter are mere human beings subject to greed and fear and corruption … it’s called human nature.
What if CEO’s know they can take on outsized risk and that, because there are no regulation, no one can say they did anything illegal at the end? So, you take these huge risks, make a boatload of money for a few years, crash the economy and then go retire in the Bahamas and never get prosecuted because you never technically did anything illegal?
That’s why there are regulations. To keep things like THIS from happening. And make no mistake, that is exactly what just happened. These men robbed our economy and now no one can prosecute them because there were no laws in place that said they were doing anything wrong at the time….That’s beyond absurd. I am all for free markets, but there must be a framework within which these banks work. Some simple laws would have kept a lot of this risk taking from ever occurring….
Cullen,
For the most part we’ve been agreeing, but you’ve also ignored my several comments about what I have been calling the price of failure….it is not only company dissolution, it also includes exec wealth claw back…..for the very purpose of preventing the scenario you describe. Thanks, krb
Culle,
you are slightly off base here:
1. Bankers can still be prosecuted now like in the S&L crisis. There is just no will.
2. In a free market a banker that still pulls this out has to cope with bad reputation and maybe the prospects that he will never be able to work in a bank again. Or still some legal prosecution / claw back on the basis of gross negligence or whatever.
InvestorX
How many bank bailouts were there in the 40s, 50s, 60 and 70s under Glass Steagall?
You mean the Pre-Nixon period before the holders of the U.S. U.S. dollar lost faith in the U.S. government’s ability to cut its budget and trade deficits and started issuing modern fiat money. Then lending and credit started to extrapolate.
“and the US started issuing modern fiat money”.
On another web site http://www.econospeak.blogspot.com, the current article’s author wonders why we should ever pay back our debt, when other countries do so?
One commenter wondered why we should even pay interest on our debt, when the debt was created by the government itself?
It’s as if the asset side is real, for we use it to pay current expenses.
But the principle of the liability is fictional. We should keep rolling it over, forever.
The author does say we can pay the interest (even though part of the interest is paid by isssuing more debt).
This is total nonsense to me – using the asset side of money creation immediately and ignoring the principle of the liability side, forever.
Then, I thought of MMT, and the idea of , as I understand it, not needing debt, for the government can create money out of thin air, with keystrokes.
Now, that reminds me of the conversation we are having when Cullem agrees wholeheartedly that banks need to be regulated if they have FDiC insurance.
How does that carry over to regulations needed in MMT, in which the powers are infinitely greater than the banks?
Don Levit
milton freidman versus phil donahue…..awhile ago, but it’ll make your hair stand on end:
2 min. version:
http://mjperry.blogspot.com/2009/07/happy-birthday-milton-friedman.html
long version:
http://freemarketmojo.wordpress.com/2009/07/20/what-is-greed/
Cullen,
In your scenario, the CEO takes on outsized risk and crashes his company. The investors take the hit … afterall, lack of due dilligence should not be rewarded, should it? Result? Investors are far more careful about where they place their money are far quicker to pull their money at the first sign of a rogue CEO. It was probably little consilation to Enron shareholders that Ken Lay did some time … I think they would have rather they had did their due dilligence. BTW, no one is saying that failure to disclose information for the perusal of shareholders should not be illegal.
Likewise, you say that these men robbed our economy, actually no. The robbery happened at the point that the tax payer bailed them out. Before that point there were just a load of CEO’s and shareholders who were just about take a serious hair cut.
You seem to be okay with the potential of one or two banks being able to crash the US economy? Why should there not be safeguards in place that protect us all from that?
It’s crystal clear that de-regulation contributed to the size of these banks and their ability to do what they did. I don’t see how anyone can justify not regulating these institutions….
Is it crystal clear? The only thing that is crystal clear to me is that these banks knew they would be bailed out. They learned that lesson from the LTCM debacle and no doubt had some assurances from other sources.
What makes that you think that several banks hiting the wall and taking down their share holders with them consitutes a crashed economy? As long as retail depositors are safeguarded, what does main street care? New banks will quickly spring up to take their place and they had better act responsibile or their shareholders will run for the hills.
Let me ask you a simple question. If homeowners were forced to put 20% down would this crisis have ever happened? I don’t think so. And I don’t think that’s too much to ask of someone who is making the largest purchase of their life. Sure, the banks don’t like it because it eats at their potential profits, but you know what? A simple regulatory measure like that keeps the economy from ever experiencing a housing bust like the recent one….The same goes for putting down collateral of OTC derivatives. There are some really simple common sense rules that could have prevented all of this. But the banks don’t like the rules and they pay off Congress to make sure these laws never get passed….We all are at risk because of it.
Cullen,
Fist off I agree that we are all at risk.
On one hand that you assert that a regulation of 20% down would have prevented the crisis and then you go on to point out that Banks pay off congress to stop the law being passed or finding ways around it. Is that not a contradiction?
I will say this, if you can find a congress made up of congress men and women who are immune to bribery, coersion and corruption then I will be very happy to see your regulation of 20% down. Until that time, I want to see that the option of bailouts for banks is completely off the table. I want to know that banks know that if they screw up they are going down along with their shareholders.
Boatman posted a clip of Friedman. I think Friedman was an estute Econimist but I consider him an even more estute observer of human nature. He knew full well that there are no Angels in congress or anywhere else in banking for that matter. Bailouts need to be off the table for ever. They are pure moral hazard.
Cullen,
There might be some good people out there but they don’t make it very far at all in the world of politics.
You wrote:
“This free market nonsense is based on this false idea that we are evolved to the point of being entirely rational. Well, that’s just not how it works in the real world. People will do anything to get ahead in life and if it means screwing other people then they do it. That’s why laws exist. To protect the innocent from those who are willing to do anything to get ahead.”
To my mind you seem to have it completely backwards. Free Markets are brutal, they take no prisoners, they don’t care if you rational or not. You fuck up, you take the hit. You are careful, prudent and do your due dilligence, you get rewarded. What have your so called ‘laws’ done for the innocent taxpayes? Have they not allowed them to be fucked over as you say. Have they not allowed the perpertrators to press the restart button and go again like some kind of computer game?
It’s the planned economy idea of rational people passing rational laws that relies on the myth that we have evolved into something other than greedy human beings succeptible to coercsion and bribery.
Why do you think the framers of the constitution pointed out the limited actions that the government could take … it is because they knew full well that government is nothing more than imperfect men leading imperfect men. The framers of the constition aimed to tie them down in a such a way that they could little damage.
You want to stop moral hazard on wall street, take away bailouts.
Where are these brilliant economies that were built by central planners and regulators?
You’re starting your entire analysis from the the conclusion. If there are simple rules in place we never have to bailout anyone….
Cullen,
You wrote:
“You’re starting your entire analysis from the the conclusion. If there are simple rules in place we never have to bailout anyone….”
We are going round in circles. It seems to come down to you believing that if we have simples rules in place they will be followed. I say good luck with that! I on the other hand see no examples in history that this is the case.
My solution is this. If a bank is to fail, and the tax payers are to bail them out, put it to a referendum, let the tax payers decide. This way no one can bitch afterwards, the tax payers get what they ask for. In other words, what is the best way to keep congress honest on this issue, take the issue out their hands.
My point is, if you require basic rules (like a homeowner to put 20% down) then you never have to worry about mass bailouts and a housing crisis to begin with….Forget the bailout part. I don’t even want to confront that. That’s like arguing whether we need the electric chair for people who throw bombs in crowded streets. If you make the bomb illegal and impossible to get a hold of beforehand you can virtually eliminate the potential of ever even having to confront this scenario. Bad example, but you get my point….
But pepole like you say, “no, let them use bombs all they want and if they kill a few people along the way then let the markets deal with the clean-up.” That doesn’t make a lot of sense to me….I am 100% anti bailout, but I am also against allowing a lack of regulations to set the foundation for bailouts to begin with….
Cullen,
I go fully with Gekko on that: You create regulation, you imply bailout and this means banks will find a way around the regulation. You put a 20% down rule, then banks will create a bubble in something else (which you have not regulated). So you relly have this backwards. What works in naturally greedy systems is proper incentives, not wishful thinking regulation. Of course every game needs rules, which are clear. But rules are not regulations.
Even if a banker crashes the system, if his punishment is severe enough, there will be little copy cats next time round. The depression may be deep, but it will be SHORT!
InvestorX
Again, this is a very simple rule, but there is no loophole around “20% down”. It’s that simple. There are rules that could have been implemented that keep these sorts of crises from blowing up into these catastrophic events….
Cullen, Gordon G, Mediocratis, Angry, et al.
Thanks everybody!
I regularly follow 6 financial blog sites. While we may have some differences of opinion or degrees of difference in our views of more or less regulation being required to bring stability to the system, this has been the most enlightened debate on the topic I’ve seen on any of the 6 sites in the last 3 years.
Nice job! I wish this debate could now take place inside the institutions that could actually do something about it. Instead we get middle school level debate…..and I apologize for insulting middle school students. Thanks, krb
Cullen,
“We are greedy, evil, selfish creatures and if we’re given the opportunity we will totally fuck you over if it means I win.”
Maybe that’s the world you live in, the people you know or maybe just Wall Street in general but I got news for you. There are a whole lot of people out there who don’t play by those rules. Maybe thats the crowd you run with, who you know or who you deal with but take my word for it, there are many people out there who don’t live in your world. Call em stand up guys, straight shooters or just plain good people. Yea it may come as a shock but we are out there and maybe that’s what we find so disgusting about the last few years and the bullshit coming out of your world.
Take it easy sonny. If you think I am one of the bad guys then you haven’t been reading long enough….But I know they are out there. I know that unrestrained humans will do whatever it takes to survive. It is human nature. I am not saying everyone is like that. But there are plenty of them out there who will do it.
I left a great job at Merrill Lynch because my moral compass couldn’t deal with it. Tell me how many people you know who will admit that….Not very many is my guess….So don’t pass judgment on me for what you know damn well are comments that condemn a very small portion of the population….
What makes that you think that several banks hiting the wall and taking down their share holders with them consitutes a crashed economy?
That’s the great thing about learning from history — it isn’t necessary to ask questions like this.
Because anyone who bothers to learn about past depressions understands exactly what happens when large pieces of the banking system are allowed to collapse. And those things are not good.
Angry MBA,
it would seem that not everyone learns the same lesson from history. We have a debt based economy, our depressions have come about by the consumer and business reaching debt saturation point. After this, the only way is debt (money as debt) destruction.
You go to say:
“Because anyone who bothers to learn about past depressions understands exactly what happens when large pieces of the banking system are allowed to collapse. And those things are not good.”
Is that so? That’s why the Japanese are still in deflation more than 20 years after NOT letting large pieces of the banking system collapse.
I for one am not for rewarding moral hazard. Live by the sword, die by the sword.
I for one am not for rewarding moral hazard. Live by the sword, die by the sword.
Again, I know that’s really fun to say on the internet, but you obviously don’t see the linkage between deposit insurance and the inherent socialization of losses.
The reason that we have an FDIC is because the Great Depression saw the failure of 40% of US banks. Most people associate the Depression with the ’29 crash, but the essence of the problem was the failure of the banking system in 1931-2, which lead to a prolonging of the economic downturn.
The “banksters” of the day paid the price, but at the expense of 25% unemployment and an underfed population. The moral hazard was suffered by tens of millions of people who had nothing to do with the banking system. Our situation today is vastly better than that.
That’s why the Japanese are still in deflation more than 20 years after NOT letting large pieces of the banking system collapse.
No, the Japanese problem goes beyond banking. And if you look at Japanese demographics, then it should occur to you that the Japanese may actually want deflation as a means of funding their rapidly aging population in the face of negative population growth and policies that limit immigration. The US is not in the same position, on many levels.
Angry MBA,
why do you keep banging on about ‘how fun it is to say things on the internet’ as you say? Not my idea of fun.
You said
” …you obviously don’t see the linkage between deposit insurance and the inherent socialization of losses.”
I still have not heard you explain why securing retail deposits can be considered socialising losses. Care to explain?
Also, you seem to imply that a bank keeping it’s profits in good times and passing off (socialising) it’s losses to the tax payer in hard times is not a bad thing. Is this what you believe?
I don’t agree with your take on the Japanese economy or the great depression but that is a whole different conversation.
I still have not heard you explain why securing retail deposits can be considered socialising losses.
It’s pretty straightforward — deposit insurance passes the risk of those who loan money to the bank (the depositors) to the public. The depositor is protected at the expense of everyone else who isn’t a depositor.
you seem to imply that a bank keeping it’s profits in good times and passing off (socialising) it’s losses to the tax payer in hard times is not a bad thing.
It’s reality. Banking losses are necessarily socialized, because of the relationship between credit creation and the stability of an economy.
These are impossible to separate. If the banking system fails, the entire economy fails with it.
Wanting to get back at the banks is as good as cutting off your nose to spite your face. It’s a waste of energy, and not worth bothering with.
Angry MBA,
You wrote:
“It’s reality. Banking losses are necessarily socialized, because of the relationship between credit creation and the stability of an economy.
These are impossible to separate. If the banking system fails, the entire economy fails with it.”
This might reality to you, however please don’t assume that your really is actually reality. From where I am standing it certainly is not. I maintain, instead of bailing out wall street, simply guaranteeing the deposits and letting the bad banks take their medicine would have probably seen us through the worst without much pain on main street.
I idea that banks and the economy are impossible to seperate seems illogical to me.
I maintain, instead of bailing out wall street, simply guaranteeing the deposits and letting the bad banks take their medicine would have probably seen us through the worst without much pain on main street.
You must be a big fan of depressions. Again, we have lessons from history that show what happens when such prescriptions are followed, and the results are catastrophically bad.
And you haven’t explained where all of those deposit insurance proceeds were supposed to come from. Had the insolvent banks all failed, the FDIC would have been wiped out several times over.
I don’t disagree in principle but I am not confident our bureaucrats are qualified and not too captured (or corrupt) to pass regulations that would not make things even worse. After all, Wall Street writes the bills for them, either directly or through the revolving door.
It also worries me to see anyone who is suspicious of more regulation characterized as an ideologue or right-wing zealot. The government is directly responsible for banks not having to sleep in the beds they have made, I don’t see how this can be argued against. The government played a large roll in making 20% down payments a thing of the past, but now we want this same government to pass a law requiring 20% down? Why would you ever expect them to do that, or trust these same people to write better laws ‘next time’?
I think it would be pragmatic to consider these facts before we hand over the keys to the ‘I feel your pain, we’re here to help you’ central planners. Ad hominem attacks against those who simply point these things out does nothing except make the attacker feel better about their own ideology.
There are many more factors as well of course. How can anyone discuss new regulation without a thorough consideration of how incompetent the government was at enforcing what laws ‘were’ on the books? Where are the fraud charges against these banks?? No laws, BS. Captured regulators who can’t bring fraud charges against bankers because the central planners at the top have agreed the bankers must be saved at all cost. These are the people we want in charge of writing new laws?? Maybe if there were a new sheriff in town I wouldn’t be so concerned, but I just don’t see that happening. The revolving door is fully functional.
The government is here to help itself and its friends, not you and me. Believe otherwise and call me a zealot, it will make you feel better. But the world works on incentives and consequences, not crocodile tears and good intentions (our politicians’ specialty). Provide incentives and enforce consequences. Our government has proven wholly incompetent at both over the course of the most recent boom and bust. They have made things worse. The burden of proof falls on those that want to put their faith in trusting these people with writing new and better regulations, not those who are suspicious of said faith.
Cullen,
You wrote:
“My point is, if you require basic rules (like a homeowner to put 20% down) then you never have to worry about mass bailouts and a housing crisis to begin with….Forget the bailout part. I don’t even want to confront that. That’s like arguing whether we need the electric chair for people who throw bombs in crowded streets. If you make the bomb illegal and impossible to get a hold of beforehand you can virtually eliminate the potential of ever even having to confront this scenario. Bad example, but you get my point….”
By all means, have your regulations. I for one have little faith that they will stop the perpetrators. I would be very happy if they did though! However, if they fail I want to see that bailouts must NEVER be on the table. Unless the tax payers can take a vote on it themselves.
We are in total agreement about the bailouts. I just think we have to remember that these banks are profit motivated institutions. That means they are going to take excess risk if allowed to. Therefore, we should implement rules that mitigate risks. I think it can be done if we have the right people in charge, but perhaps you are right and it’s a hopeless endeavor. I still have faith that it can happen one day….
Cullen,
I just have one more question for you. Do you or do you not believe that bailouts of any kind being completely off the table will have any effect of the actions of banks in terms of their lending practices and risk taking?
Not really. These institutions are so large and important now that they know we have to bail them out. You don’t think that’s part of the construction here? They have created this systemic risk intentionally. That way, they can take the huge risks and then convince everyone that we’re totally screwed if they fail. And they might be right. Letting all of the banks fail in 2009 could have really resulted in a depression. Is that worth it? You’re basically encouraging depressions once every 50 years…..There’s no need for it. The goal should be to mitigate the risk entirely. Not allow it to occur everyone once in a while. And yes, under your model it will occur every once in a while. Memories are short. Shorter than your self correcting mechanism assumes….
Cullen,
you have not answered my question. If bailouts are categorically off the table upfront, will it effect the banks behaviour with regards to lending and risk taking? Or if you will not answer that question, let’s say we are to put the baillout question to vote of taxpayers? Again, will it effect the banks behaviour with regards to lending and risk taking? I would appreciate an answer to the question please.
Gekko,
I definitely think it will impact their operations for a period. That’s why I always talk about having capitalism with losers. Losers must lose. There must be repercussions. But I am also realistic. If we go 75 years without a banking crisis and we tear down all of the regulations then it’s inevitable that someone will get complacent and do something stupid. So, then we have 2008 and under your model the economy craters. Everyone learns their lesson and we go another few decades without a crisis. Rinse, wash, repeat. It is human nature to forget the past and become complacent. Under a model without regulations you can guarantee that it happens. Go back and study the 1800′s and early 1900′s before Glass Steagall. We had a banking crisis once every few decades. Why? because people forget the past and get complacent…..your “lessons” wear off soon after they are learned….
Cullen,
Don’t forget, your “regulations” wear off when the good times are rolling as we have learned …
ok we are dealing a debt (debt as money) based system and there will be periods of expansion which require necessary periods of purging of debt from time to time. We are dealing with congress and regulators who are prone to bribery, coersion, lobying. We have one tool at our disposal. Regulation. We have another tool available, the fear of knowing that there will be no bailouts. Why not use them both. Even better, why not put decisions that would scrap regulation and have bailouts in the control of the tax payer in referendums. Why not start from the assumption that the perpetrators are always going to be trying to take advantage and use all our tools at our disposal to make it as hard as possible for them to do that.
I don’t know. That 20% rule sure wouldn’t have worn off….
I like the idea of the referendum for not bailing them out…however, simply refusing to bail them out isn’t enough…placing them in a round plastic lined room with a water canon controlled by wii stations in every household the US televised on YouTube might work as an added deterrent.
People who run the institutions take no real risk. They are employees. They stand to gain greatly if their bet pays (through bonus, pay and perks). The MOST they can lose if their bet fails is their job, and that’s not a super-huge disincentive. These people are all well-connected and a new job is always there for the asking, and most of them have golden parachutes anyway.
Allowing institutions to fail hurts customers and non-executive employees. The people it doesn’t hurt are the people who failed in the first place. Perhaps the government shouldn’t step in and rescue failing institutions, but it is folly to believe that allowing the failure will end the behavior. Look at the evidence.
BTW, today is my first time posting on this site, although I have been reading for a while. So hello everyone! I have to say, it’s a breath of fresh air.
Thanks for commenting Gekko. We like the different perspective and I really encourage a challenging and alternative outlook. I don’t have all the answers and neither does anyone else, but we can come to some sort of common ground through intelligent debate. I wish Congress was having these sorts of rational discussions.
There was excellent operational insight behind Glass Steagall; it was necessary to keep the wolves of Wall Street away from the lambs in commercial banking and insurance. When Glass Steagall was repealed, my partners and I laughed and asked ourselves: what in heaven’s name are they thinking? Glass Steagall is about 18 pages of very smart legislation whose time will come again. Bailing out of bank bondholders (that began with Continental Illinois) also has to be stopped.
20% down is an underwriting standard for mortgages whose abandonment was just one aspect of a complete breakdown of risk underwriting on residential mortgage lending due to government guarantees and the securitization model, which was supposed to pass off risk to the greater fool, which it did until Wall Street choked on its own inventory late in the cycle and the dumb money pinata called AIG became TBTF. This was moral hazard squared. Reinstating 20% down is just a band aid on a dangerous systemic condition afflicting the US and world economy.